Private clients and their advisers should be asking themselves (and each other) if they are sufficiently prepared for the Common Reporting Standard ("CRS").
Implementation of the CRS is gathering pace around the world, with the first reports now being prepared for automatic exchange during 2017. We continue, however, to see varying degrees of chaos in the approach to implementation taken by different banks. We are also receiving an increasing number of enquiries from those in need of assistance with CRS matters, from determining the classification status of an entity under the CRS to understanding exactly what information will be reported and exactly where and when it will be received.
Aspects of the CRS are complicated and modes of implementation and local guidance differ from country to country, so it is hardly surprising that many find themselves confused or in need of assistance. Opportunities may exist to plan the flow of information, which is often desirable in view of the disproportionality of reporting in some cases – particularly for certain trusts.
This article highlights some of the subtleties of the CRS that should be considered by those affected.
In the majority of cases determining the CRS classification status of an entity (i.e. Active NFE, Passive NFE or one of the categories of Financial Institution) is a straightforward exercise, but in some cases it can be more complex. The fact is that CRS entity classification is not always an exact science and so reasonable people may reach different conclusions.
Common controversies include whether a particular entity (including a holding company) qualifies as an Active NFE and whether a particular trust is an Investment Entity Financial Institution or rather a Passive NFE.
The result of the entity classification exercise makes a critical difference in terms of obligations arising as well as the eventual flow of information in practice. In the case of trusts it may also determine the extent to which information reported will be disproportionate (more on this below). Understanding these effects is an important further step in your CRS preparations.
Due diligence processes
Entity classification also determines whether your entity must undertake its own due diligence (because it is a Financial Institution) or only assist with the due diligence requests of Financial Institutions which maintain the entity's accounts (because it is an NFE). The tasks involved will be similar in either case and, whichever side your entity is on, it will help to be prepared for further queries concerning, for example, the tax residency of an entity or individual and whether or not a Tax Identification Number (TIN) should be provided.
Early or late adopter is not the whole story
Most readers will be aware that the 100+ countries implementing CRS are relatively evenly divided between those that have committed to implementation as early adopters (reporting information relating to 2016 during 2017) and those that have committed to implementation as late adopters (reporting information relating to 2017 during 2018). But this is the not the whole story.
Although most jurisdictions are using a multilateral legal instrument as the legal basis for implementation of the CRS, the actual automatic exchange of information in practice requires specific activation of exchange relationships on a bilateral basis. It is not necessarily the case, therefore, that all committed countries will be exchanging with each other by 2018 when the late adopters begin exchanging.
Indeed, it has been confirmed that bilateral exchanges between certain countries will not take place before 2019. Switzerland is a notable example, with many of its potential exchange relationships currently set to begin reporting in 2019.
Trusts and disproportionality
Discretionary beneficiaries of trusts that are Financial Institutions receive relatively reasonable treatment under the CRS – they are only reportable for years in which they receive a distribution and the financial information required to be reported is only the gross amount of distributions made to the beneficiary during the period. Furthermore, if a discretionary beneficiary receives a distribution in one year but not the next, this does not constitute an account closure - which itself is a reportable event.
The default reporting treatment of discretionary beneficiaries of trusts that are Passive NFEs, on the other hand, is that they will be attributed 100% of the value of and activity on a financial account. This is notwithstanding that they may never receive a distribution and, moreover, that they may not even know that they are a discretionary beneficiary of the trust in question. This is an extremely disproportionate result.
The conclusion drawn may be that it is preferable for a trust to be an FI. In most cases this is true. But it may not be true if, for example, the trust has no accounts maintained by Reporting Financial Institutions, or if reporting between the relevant jurisdictions is not yet effective - and it is surprising how many such cases we have seen.
The saving grace for discretionary beneficiaries of Passive NFE trusts is that in implementation of CRS jurisdictions have the option of allowing Reporting Financial Institutions to align the scope of reporting of discretionary beneficiaries of Passive NFE trusts with those of Financial Institution trusts. This raises further questions about implementation, such as how (or if) banks and other FIs can keep track of distributions. Furthermore, the bad news for those within the EU's framework for implementation of CRS is that this option does not exist in the Directive for Administrative Cooperation.
Another example of disproportionality in the CRS is that the holders of joint accounts are also reported in respect of 100% of the value of those accounts.
The obvious concern here is that tax authorities receiving reports of disproportionate information may open audits or enquiries, which may go on for a long time at great personal and financial cost to the taxpayer.
Differences in implementation
Differences in implementation are inevitable with each country needing to give effect to CRS through its own domestic legislation and guidance. Indeed, the CRS allows jurisdictions a variety of options in relation to specific matters (including the alignment of the scope of reporting of discretionary beneficiaries of different categories of trusts, as outlined above).
Perhaps the most fundamental of differences is the choice between adoption of a "normal", "wider" or "widest" approach to due diligence and/or reporting. The "normal" approach requires financial institutions to undertake due diligence only on those persons who are resident in "Reportable Jurisdictions" (those with which a bilateral exchange relationship has been activated). The "wider approach" requires due diligence on all accountholders irrespective of tax residency, with reporting being required only on persons in Reportable Jurisdictions. At the furthest end of the spectrum, the "widest approach" requires Financial Institutions to report all accountholders (including Controlling Persons of Passive NFEs) to their own local tax authority irrespective of whether they are resident in reportable jurisdictions. It is then up to the domestic tax authority to determine which reports to pass on to foreign tax authorities pursuant to an activated bilateral exchange relationship. Most jurisdictions (including, for example, the UK) adopt the "wider approach". But some (including, for example, Australia and the UAE) adopt the "widest approach", which provokes greater concern among those who object to the CRS on the grounds of data security and the right to privacy.
The CRS allows financial institutions to avoid conducting due diligence on pre-existing entity accounts with a balance or value not exceeding US$250,000 as of 31/12/2015 (or conceptually distinctive groups of such accounts), unless and until the balance exceeds this amount on 31/12 of a subsequent year. Accountholders might wish, therefore, to enquire of their bank as to whether this option is being followed. Legislation implementing the CRS in the UK requires financial institutions to make a specific election to adopt this option.
The above should at least provide some food for thought on your preparedness for CRS. In many cases there will still be plenty of time to clarify matters of uncertainty. We have developed considerable expertise on the CRS and we will be delighted to assist with queries.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.